“Holding the next governor accountable will be as important as choosing one. The Bank of England was rightly given considerable independence in 1997 to prevent politicians meddling in monetary policy in order to advance their electoral interests. But the institution and its leader have slipped up on enough occasions that leaving them entirely to their own devices isn’t a good option either.

For example, King didn’t sound the alarm loudly enough during the credit bubble and was slow to act when there was a run on Northern Rock, the mortgage bank, in 2007. He then long resisted any investigations into the Bank of England’s own failings in managing the crisis. Now its hands-off approach to the Libor scandal is being revealed.

Based purely on its record, the central bank wouldn’t be receiving extra powers. However, the Conservative-led government has tried to pin the blame for the credit crunch on the previous Labour government’s policies – in particular, its decision to take away the central bank’s responsibility for banking supervision. Hence, it has become politically convenient to reverse that move.

Given this, the priority should be to enhance the Bank of England’s accountability. Under the current system, the government sets inflation targets and picks the governor. It also chooses the deputy governors and members of two committees: the monetary policy committee which sets interest rates; and the financial policy committee which will soon be responsible for financial stability. Their independent members help prevent the governor becoming too dominant.

The Bank of England also has a board, called the Court. But this has been largely ineffective. Though it has recently stepped up its scrutiny of the central bank’s executives, it is hamstrung because it rightly has no say over policy or who is the governor.

Meanwhile, parliament can call the governor and other senior officials in to give evidence. Although this is a potentially important check to the central bank’s power, MPs haven’t yet used this tool effectively.

…

One way of improving democratic control would be to give MPs the right to hold nomination hearings and, in extremis, reject the government’s choice for governor and other top positions. Indeed, that’s what parliamentarians want. But the government is resisting. If MPs are to change its mind, they must first show they are up to the job.”

Let’s come back to this when we’ve diagnosed the problem.

Because I still feel I haven’t made my point fully.

What the Libor affair shows us is that regulation must be mechanical, not moral.

This is a lesson we failed to learn from King’s behaviour during the financial crisis, despite his starving the UK banks of liquidity in a misguided attempt at preventing “moral hazard”; his expressed desire to stitch up Lloyds shareholders with a backroom deal to take over Northern Rock; and the actual outrageous stitch-up of Lloyds shareholders with a backroom deal to take over HBoS without adequate due diligence, to which he must at least have given a nod.

“The excuse for laying into Diamond seems to be some problem with the ‘culture’ at Barclays. Is it any different to that at any other investment bank? Doesn’t the ‘culture’ in any occupation go with the turf? Presumably they don’t want traders to behave like, say, Premier League footballers, or Hollywood actors. Something less flash perhaps: doctors, say or IT guys. But would they still be able to do the job? These occupations surely require quite different qualities and aptitudes. Maybe something a little more sales oriented, perhaps, then: used car dealers or estate agents. Or politicians! But are these professions more or less honest than investment banking? I’m stuck. Perhaps our politicians could spell out exactly how they want investment bankers to behave.”

The aim of yesterday’s post was to develop the idea that the “scandal” is being treated as a moral issue. There’s something “bad” about Barclays, we’re told, and the Bank of England Governor, with ex officio moral authority, judges it comes from the top and fires the Chief Executive.

“Culture is not a fluffy chimera of business how-to books or self-congratulatory corporate reports. Culture, real and unnoticed as the air we breathe, is the web of unspoken mutual understandings that frame what people expect from others and think is expected of them. This web shapes the fortunes of any organisation or social group. Bob Diamond, Barclays’ disgraced ex-chief executive, knew this; he once declared ‘the evidence of culture is how people behave when no one is watching’. He was right…

… [non sequiturs omitted]

A culture cannot be heavy-handedly ‘managed’ by legislation or compliance rules alone. It must be more subtly cultivated and tended.”

OK, we can all agree that behaviour within an organisation is determined by executive example and communications; organisational stories; dress code; building architecture, location and decoration; the presence or absence of game rooms; and so on and so forth – as well as the nature and demands of the work, as I previously stressed. But within all that complexity, all we’re really concerned about here is that rules are followed. There may be indirect ways of achieving this goal by means of some kind of arcane cultural alchemy – would Fairtrade coffee, beanbags and dress-down days work? who knows? – but most people would consider it sensible to simply focus on the outcome.

Obviously the “rules alone” are not enough. There also needs to be an expectation of enforcement. A rooting out of dishonesty. And maybe by spending £100m on investigating Libor-fixing rather than, say, carrying out some “routine email housekeeping” (didn’t something like that come up with News International?), Barclays have shown a willingness to steer their internal culture in the direction of obeying the rules.

With this unsatisfactory view of “culture” in mind, let’s consider the crucial question for the future, the “Mervyn King Question”: Is it possible for the Governor to both exercise moral authority AND for there to be effective oversight of the role?

No, of course not. The Governor can’t both exercise his judgement AND explain the detailed reasons for a decision. If he can explain the precise reasons to whoever he, the Governor is accountable, for example those for firing Bob Diamond (“he broke rule 44b clause 3, which is a sacking offence”), then by definition he isn’t exercising judgement.

The Mervyn King Question suggests then that we have to decide which way we jump. Do we want, in the modern world, to trust the personal judgement of an unelected official, or do we want a team expert in banking regulation to ensure that the rules and sanctions for breaking them are clear to banks and that bank behaviour is monitored and the rules enforced?

Do we want a ruler or do we want rules?

The traditional role of the Governor of the Bank of England was one of arbitrary power. This is where Mervyn King believes we should return. No wonder the job of Governor is so coveted.

But there’s a different path. Surely we’d be better off rejecting the moral approach and focusing on the technical aspects of the role of Governor of the Bank of England?

Let’s take as an example the critical case, where it all started to go wrong, when I first became concerned about the outlook of Mervyn King. Instead of arbitrarily allowing banks (such as Northern Rock) to fail to try to prevent “moral hazard” shouldn’t the Bank have made the rules absolutely clear in advance? NR would not, I’m sure, have relied on interbank funding had it’s executives known that funding may be allowed to dry up and they would have to retire in disgrace.

I would suggest that the Bank start by announcing that it will not allow any Bank to fail due to systemic problems (as opposed to Baring-style sudden catastrophic losses), but will provide liquidity as lender of last resort. What constitutes “systemic” would need clear definition, as would the cost of such support which would include a requirement for banks to raise capital. We have to recognise that we can never allow banks to fail under stress – such failures simply cascade through the economy – and dismiss the nonsense that such a backstop is some kind of subsidy for institutions that are “too big to fail”. This is like saying that Tesco is subsidised because the State provides resources for the prosecution and punishment of shop-lifters.

The Libor-fiddling that mattered – that before the financial crisis – was arguably criminality, pure and simple. It was orchestrated by a small group of traders who knew they were breaking the rules, as their emails make clear: “I would prefer this not be in any book!”, “if you breathe a word of this I’m not telling you anything else” and so on. It became a “scandal” because politicians – principally Ed Miliband – immediately made hay. But business isn’t politics. It’s not primarily about character (neither should politics be, of course, but the UK political process is becoming ever more Presidential and less policy-driven). The danger of allowing the political process to drive banking or other business regulation is that there is no satisfactory answer to the Mervyn King question. Even were we to confer moral authority on the Governor as we do the Prime Minister (who is not only elected, but easier to get rid of than the Governor – men in grey suits and all that), business is not hierarchical like government. It is fundamentally about choice and competition. Differences in outlook are necessary.

Dismissing company bosses in an attempt to change the corporate “culture” would seem to necessarily worsen group-think. If all our banks had been the same perhaps they’d all be part owned by the State now. Perhaps they’d all been like HBoS. As it is, Barclays managed to recapitalise without calling on government funds, Santander expanded and the “elephant” HSBC simply marched on barely affected. Diversity matters.

At worst, of course, there is no difference between condemning a bank’s culture and firing the boss simply because you don’t like the cut of his jib.

I promised I’d return to the points Hugo Dixon made. We may well need some or all of the means Dixon suggests for holding the Governor to account. But before we can do that, Parliament needs to step back and look at how the Governor’s role is defined. They need to review his Terms of Reference. Make sure he’s clear what the rules are.

July 18, 2012

If you’re going to watch one film about the Vietnam War then I recommend Hamburger Hill. The point of the film for me at least (other discussions of the movie fail to stress this point) was that the battle was not about the strategic value of the eponymous high ground. Rather, both sides were trying to demonstrate their determination.

Catching up with an episode of Mock the Week last evening, I chanced on a rant by the one I would refer to as the tall, skinny panelist with dark curly hair, had the internet not been invented purely to allow me to remind myself that his name is, in fact, Chris Addison. The comic – who I always feel differs from his generally less hirsute colleagues in looking less like a funny-man, and more like a particularly tedious sociology lecturer – observed at some length that everyone is furious about the Libor “scandal”, even though most of them they don’t have a clue what it’s about. Well observed, in my opinion.

My first post on the Libor topic attempted to convey this moral dimension – and the battle for authority – with its title, Saint Mervyn: King by Name, King by Nature, but perhaps I wandered slightly off the theme, in favour of providing a narrative.

It seems clear after Mervyn King’s appearance before the Treasury Select Committee yesterday, though, that the Governor chose the Libor issue as the ground on which to continue a war with the City, and in particular with Bob Diamond. We’re told that Diamond’s sacking was not just about the Libor issue, but about Barclays’ “culture”, and a “pattern of behaviour”, as discussed in correspondence between Lord Turner, head of the FSA and Marcus Agius, Barclays’ Chairman. It seems clear that nothing new had emerged to implicate Bob Diamond personally and that King therefore simply seized the opportunity to get rid of him. Here’s how the Guardian puts it in an editorial:

“And why exactly was Mr Diamond pushed out? Not for any direct involvement in the Libor scandal but, in the words of Mr King yesterday: ‘They [the bank] have been sailing too close to the wind across a wide number of areas.’ No actual infraction; just a general sense of having gone too far for too long. … The impression left is of rather rough justice.”

By Brooke Masters and Patrick Jenkins in London and Justin Baer in New York

Regulators probing alleged manipulation of a key interbank lending rate have focused their demands for information and interviews on five global banks, according to people familiar with the investigation.

UBS, Bank of America, Citigroup and Barclays have received subpoenas from US regulators probing the setting of the London interbank offered rate, or Libor, for US dollars between 2006 and 2008. …”

Who says bookmarking thousands of interesting news stories is a waste of time, eh?

By Brooke Masters and Patrick Jenkins in London and Justin Baer in New York

Regulators in the US, Japan and UK are investigating whether some of the biggest banks conspired to ‘manipulate’ the benchmark interest rate used to calculate the cost of billions of dollars of debt.

The investigation centres on the panel of 16 banks that help the British Bankers’ Association set the London interbank offered rate, or Libor – the estimated cost of borrowing for banks between each other.

In particular, the investigation was looking at how Libor was set for US dollars during 2006 to 2008, immediately before and during the financial crisis, people familiar with the probes said.

The probe came to light on Tuesday when the Swiss bank UBS disclosed in its annual report that it had received subpoenas from three US agencies and an information demand from the Japanese Financial Supervisory Agency. …”

When were these stories published? 15th and 16th March, 2011.

Now, I may not be willing to fork out for an FT subscription, but I’m sure Bob Diamond and Mervyn King are. In fact, they probably receive the “Pink’un” as a perk of their jobs.

Regular readers will know that I’m very guarded in anything resembling an accusation that I may occasionally make on here, but it does indeed beggar belief that everyone involved is claiming to have been unaware of the brewing Libor scandal – a matter relevant to banks’ annual company reports – until the last few weeks, since even I knew about it, and the Libor-setting process was, until this month, of course, of somewhat peripheral interest to me, and even that overstates my curiosity. My £2.50 copy of the FT quotes Mervyn King on the front page as saying:

“The first I knew of any alleged wrongdoing was when the reports came out two weeks ago.”

Doesn’t the Governor read the FT? If not, why not?

To the extent I worried about it, I assumed the likelihood of fines over Libor-rigging was “in the price” of bank shares (we must be at the point where banks start assuming a few hundred mill in fines each year as part of their business plans, and therefore product-pricing). Active investors must have also thought bank share prices took account of the Libor investigation, as otherwise they would have sold the banks, short if necessary.

As I mentioned yesterday, Libor manipulation – much of which occurred during the financial crisis when the numbers were guesses anyway – would seem to be less serious than HSBC’s desultory attitude towards controls to prevent money-laundering. (Rather predictably, HSBC have seemingly gone overnight from one extreme to the other: I have recently had an HSBC account, to which I log in online 2 or 3 times a month, locked down – “suspended” so I can’t even pay into it – for no apparent reason).

No, Libor has been chosen as a battleground.

Sacking Bob Diamond makes no sense otherwise. Barclays report that they spent £100m “to ensure no stone has been left unturned” in their internal investigation and have settled early with the regulators. Since this has not been enough to keep the top guys in their jobs, perhaps their successors will adopt a different strategy next time!

And, like a misjudged military intervention, the battle threatens to turn into a war, consuming its instigators.

Mervyn King has clearly over-stepped his authority and threatened his legacy: “It is the BoE that finds itself most directly in the line of fire”, writes the FT’s Chris Giles. Not only are more and more awkward questions being asked in the UK, the regulators across the Pond are now playing holier than thou. That FT front-page lead (taking precedence over a report of the HSBC compliance chief quitting during a US Senate hearing!) is titled: “Bernanke calls Libor a ‘flawed’ benchmark”, and observes that “Mr Bernanke’s description of how the US reacted [earlier, in 2007] to claims that banks were understating the rates at which they could borrow contrasted with testimony yesterday from Sir Mervyn King.”

Mervyn King’s “pattern of behaviour” suggests to me that he may have been bullied at school. If not, I rather suspect he’s now going to find out what it’s like at his regular central-banker get-togethers.

July 17, 2012

I noted yesterday that I’d set the recorder to catch Jerry del Messier’s appearance before the Treasury Select Committee. Sadly, when I got home I found I had filled my hard disc with several hours of BBC News 24, which contained no more than 7 minutes of coverage, including “analysis” of the session. Clearly the BBC is not so bothered to get to the heart of the matter.

Never mind, I watched a bit on Parliament TV this morning, after warming up with some live coverage (thanks BBC) of Mervyn King’s appearance, flanked by his deputies and Adair Turner, like a bunch of schoolboys caught reading top-shelf magazines behind the bike-sheds.

Unlike the BBC, the MPs are trying gamely, but you really have to wonder if the process works properly. Maybe just two or three of them should ask all the questions, to avoid lines of questioning being dropped just as it gets interesting, as keeps happening when it’s another Member’s turn for a few minutes in the limelight.

Still, I wasn’t disappointed by del Messier’s grilling (you missed broadcasting some great live TV, BBC), but a couple of points seemed to pass the MPs by.

First, it finally became clear that Bob Diamond’s infamous memo was sent the day after the phone call it records, as suggested by the timestamp. Here’s the full memo:

“From: Diamond, Bob: Barclays Capital

Sent: 10/30/2008 14:19:54

To: Varley, John: Barclays PLC

Cc: del Missier, Jerry: Barclays Capital (NYK)

Subject: File note: Bank of England call

Fyi

File Note: Call to RED [Diamond] from Paul Tucker, Bank of England

Date: 29th October 2008

Further to our last call, Mr Tucker reiterated that he had received calls from a number of senior figures within Whitehall to question why Barclays was always toward the top end of the Libor pricing. His response was ‘you have to pay what you have to pay’. I asked if he could relay the reality, that not all banks were providing quotes at the levels that represented real transactions, his response ‘oh, that would be worse’.

I explained again our market rate driven policy and that it had recently meant that we appeared in the top quartile and on occasion the top decile of the pricing. Equally I noted that we continued to see others in the market posting rates at levels that were not representative of where they would actually undertake business. This latter point has on occasion pushed us higher than would otherwise appear to be the case. In fact, we are not having to ‘pay up’ for money at all.

Mr Tucker stated the levels of calls he was receiving from Whitehall were ‘senior’ and that while he was certain we did not need advice, that it did not always need to be the case that we appeared as high as we have recently.

RED [Diamond]”

I was surprised, to say the least, that none of the Select Committee noticed this delay the first time round when they might have asked Diamond what he did in the intervening time (he phoned del Messier, it turns out, though I recollect Diamond didn’t recollect this). Diamond, I remember, testified at some length that he was concerned that Barclays might appear weak whilst trying to finalise its life-saving Middle East share sale. Surely he would not have waited a day before relaying the message from Tucker.

Second, the MPs are completely failing to distinguish between different periods of Libor fiddling. From 2005-7 traders in Barclays and elsewhere were persuading the rate-setters to submit a Barclays Libor rate in order to try to make money. This is appalling – see the FSA’s report (pdf) for the salacious details. But after 2007 Libor wasn’t working. Interbank lending wasn’t happening. The FSA write:

“In the latter half of 2007 and throughout 2008, lending in London for maturities longer than overnight came to a virtual standstill and there was extreme dislocation in global money markets.”

So the banks were just making a judgement as to what they might be able to borrow at. Since it was just a guess, it stands to reason that if they were guessing higher than every other bank they may as well guess lower. “Low-balling” Libor was done for an entirely different reason from mid 2007 on – top-down from management, rather than bottom-up by traders – so as not to appear weak.

What strikes me is that by releasing Diamond’s file note, Barclays have successfully steered the MPs away from the criminality and into the increasingly murky area of Libor-setting during the financial crisis. Damage-limitation PR, basically, though that’s fairly moot from Diamond’s point of view right now, but the MPs really should have tried to distinguish between the two periods. The symptoms may be similar – dodgy Libor submissions – but the causes are different. Both hayfever and a cold might cause you to sneeze, but you’d treat the two conditions quite differently.

The Committee session with Mervyn King this morning was quite different. The Governor didn’t seem to realise he was in the dock. He was shirty with his inquisitors, and even tried to talk over one. And Andrew Tyrie seemed genuinely cross. He shared the concerns I expressed yesterday. Trouble is, dealing with King is like having a 6 foot shark on a line intended for mackerel. He seems to be pulling in several different directions at once. One minute he’s the regulator (on the grounds that the function is being handed back to the BoE), the next he’s not. One minute Diamond is being fired because of the outcry over Libor, the next it’s to do with a letter from the FSA (the Guardian has posted it here).

I hope and expect Tyrie’s report to be critical of the Governor, and the governance of the Bank of England.

Here are a couple of questions to think about:
– why doesn’t the Bank of England have separate Chairman (and Board) and Chief Executive roles? The Governor would then be – as the Chief Exec – at least accountable to someone.
– if this is what happens when they don’t like the “culture” (or just the CEO) at a bank/a few corners are cut on a poorly defined technical procedures during a once in a lifetime crisis (which all the other banks might have been doing as well)/a few traders find a new way to cheat a poorly-defined system (which might have been happening at all the banks) – delete as applicable, depending why you think Diamond was sacked – then what are they going to do when a bank does something really bad? Like, for example, allowing widespread money-laundering, as HSBC seems to have done.

July 16, 2012

I’ve been following the Libor scandal with considerable interest. The former Chief Operating Officer of Barclays Jerry del Messier should be settling into his chair before the UK House of Commons Treasury Select Committee as I write these words – don’t worry, I’ve set the recorder for the BBC News Channel.

Perhaps we’ll find out the answer to why Jerry del Messier was cleared of rigging Libor on the grounds that, according to Barclays’ briefing note (pdf) issued ahead of Bob Diamond’s appearance before the Select Committee he:

“…concluded that an instruction had been passed down from the Bank of England not to keep LIBORs so high. He passed down an instruction to that effect to the submitters.”

on the basis of Diamond’s infamous note to file which suggested that Paul Tucker, Deputy Governer of the Bank of England had advised that:

“…while he was certain we did not need advice, that it did not always need to be the case that we appeared as high as we have recently.”

The mysteriousness of it all arises because Barclays was already lowering its Libor submissions. They admit that during the period Sept 2007 – April 2008:

“Less senior managers gave instructions to Barclays submitters to lower their LIBOR submissions. The origin of these instructions is not clear.”

You’d think that when Jerry del Messier told his rate-setters to “lowball”, someone might have mentioned that they were already doing it!

I really like the point in Barclays memo that:

“[del Messier’s] instruction became redundant after a few days as liquidity flowed back into the market.”

“Became” redundant? His instruction was already redundant!

It’s not del Messier’s behaviour that really bothers me about the whole affair. It seems all the banks were at it, and Barclays may not have been the worst culprit. Barclays is just the first to settle. And the only logical explanation I can think of for George Osborne’s strange claim that Libor lowballing was sanctioned by Balls, Brown and Vadera is that it was an open secret in the City.

After all, no-one would borrow at a rate inflated by concerns that the banks might fail, as opposed to one simply reflecting risk, the base rate and the balance between supply and demand for money. Libor simply doesn’t work in those circumstances. The authorities would be obliged to address the problem any way they could in order to save the economy.

I hate to see public bullying. It seems our politicians – and many in the media and, notably, Mervyn King – just don’t like Bob Diamond. What will they do when they run out of obvious scapegoats? The excuse for laying into Diamond seems to be some problem with the “culture” at Barclays. Is it any different to that at any other investment bank? Doesn’t the “culture” in any occupation go with the turf? Presumably they don’t want traders to behave like, say, Premier League footballers, or Hollywood actors. Something less flash perhaps: doctors, say or IT guys. But would they still be able to do the job? These occupations surely require quite different qualities and aptitudes. Maybe something a little more sales oriented, perhaps, then: used car dealers or estate agents. Or politicians! But are these professions more or less honest than investment banking? I’m stuck. Perhaps our politicians could spell out exactly how they want investment bankers to behave.

Or perhaps Mervyn King could tell us. After all, he’s the one who fired Bob Diamond – never mind that the regulatory investigation is far from complete. Is he going to fire the heads of a dozen other banks?

Never mind that the real reason seems to be some problem with Barclays “culture”, it’s not actually Mervyn King’s job to sack the Chief Executives of banks. Or anyone else employed by a bank for that reason. And even if it was King’s job, he would be obliged to follow due process.

Diamond could be forced to step down if the Financial Services Authority found he was not a “fit and proper” person. Which didn’t happen.

Or if he lost the confidence of Barclays’ shareholders. He might have done, I suppose, but that’s not why he went.

“Agius told MPs that the chief executive had quit ‘because it became clear that he lost the support of his regulators’ just 48 hours before the American-born Diamond was scheduled to appear before the committee.

Agius described how he had been summoned, along with Sir Michael Rake, the most senior non-executive director on the Barclays board, to see King shortly after Agius’s resignation had been announced a week ago on Monday.

‘We had a conversation in which he said that Bob Diamond no longer enjoyed the support of his regulators,’ said Agius, who then had to hold an emergency board meeting by telephone of non-executive directors to decide how to proceed. He admitted to being shocked as concerns had not been raised when the £290m fine for attempting to manipulate Libor rigging emerged five days earlier.

Agius said he and Rake went to Diamond’s home on the Monday evening. Diamond – who had insisted to MPs last week that he did not know about any regulatory pressures – ‘was not in a good place’, said Agius. He said that the conversation was ‘not long’ and that Diamond had asked for time to talk to his family.

‘I left his [Diamond’s] house confident he would resign, if he hadn’t done so already,’ Agius said.”

Staggering.

I’m surprised there’s not been more outcry at such authoritarian behaviour by the Governor of the Bank of England, who is, after all, just a public official.

“…from the moment the credit crunch began to wreck Northern Rock’s finances in the summer of 2007, the grammar-school boy from Wolverhampton, whose father was a railway worker and then a geography teacher, was ready with his analysis. King said most of the huge debts accumulated by banks could be tied to the huge bonuses executives received as reward for their lending.

In meetings with regulators and then chancellor Alistair Darling, Diamond, then head of Barclays Capital, and his investment banking peers were seen as a bunch of amoral, greedy traders. Darling relates in his diaries how King would counsel against providing rescue funds that perpetuated a risk-taking culture.

But it was Diamond, one of nine children and also the son of a teacher, who made it public and personal. At a time when most bankers were busy trying to prevent their institutions going bust, he broke cover to give an interview in a Sunday newspaper. In an analysis of central banks’ actions in combating the credit squeeze, Diamond notably excluded the Bank of England from praise.

He said providing short-term cash was the job of a central bank. ‘For the recovery to continue we need to find more ways to get liquidity into the short end of the curve,’ he said. ‘That’s down to confidence, and that’s down to the central banks. We’ve seen thoughtful moves by the [US Federal Reserve] and the [European Central Bank].’

The Bank of England saw the interview as a direct attack on its handling of the crisis. King’s response was to embark on a series of speeches and interviews in which he openly decried the emergence of a ‘small elite’ that agreed to pay itself bonuses in good times and bad.”

So petty. Maybe Mervyn is touchy – I think Diamond was right. Perhaps, if King had behaved more like other central bankers, we’d have a healthier banking industry today, and Ed Miliband wouldn’t be threatening to break up the survivors to create more competition. Don’t forget that Alliance & Leicester, Bradford & Bingley and Northern Rock have all disappeared from our high streets.

What’s more, blaming the financial crisis on bank bonuses is simplistic to say the least.

And perhaps central bankers should have seen the housing bubble warning signs a bit earlier.

“…on whose behalf exactly was King speaking? The BoE, after all, is not responsible for supervising banks – and won’t be until next year. That’s still the job of the Financial Services Authority. If King wasn’t speaking for the FSA too, he was arguably stepping beyond his authority.

On the other hand, if the BoE governor was speaking on the FSA’s behalf, why didn’t the regulator itself deliver the message that Diamond should go? And why too did the FSA apparently change its position? After all, the regulator had only just agreed a settlement with Barclays over the Libor rate-fixing scandal. If it had wanted Diamond to go, that would have been the moment to say so.

A further question is how exactly the regulators managed to twist Barclays’ arm. If the FSA doesn’t support a bank director in his role, the current mechanism for removing the executive is to deem him no longer ‘fit and proper’. But it seems hard to argue that Diamond didn’t meet that test. After all, the lengthy investigation into the Libor scandal did not criticise him personally.

Some people will no doubt say it is good that Diamond has gone and it doesn’t really matter how that was engineered. But methods used in difficult situations can easily become precedents.

The BoE is about to become even more powerful next year when it takes over banking supervision. It is important that it operates in a transparent and accountable fashion.”

June 2, 2012

I’m not a huge admirer of Margaret Thatcher, and still less of her Chancellor, Nigel Lawson. But, back in the day, they suggested the eminently sensible idea of “currency competition” as an alternative to European Monetary Union (or, rather aptly, EMU). The idea was that the euro would be introduced alongside the pound, franc, mark and so on, with markets deciding the extent to which the international currency displaced the national currencies. But did the eurocrats listen? No, like improbably large flightless birds, they simply buried their heads in the sand.

The time for currency competition has now arrived. The case is compelling. So compelling in fact that when I scour the web to check my (in fact accurate) recall of the origin of the idea of currency competition in the eurozone, I find that it’s already been suggested as a solution to the current crisis – an alternative to Greek exit from the euro (Grexit) and Spain out (Spout) – by Philip Booth at Conservative Home. The existence of Professor Booth’s contribution allows me to make this post a little shorter than it would otherwise be. He also points out something I hadn’t previously realised – that it would be necessary to enact “a simple constitutional change to remove the clause in the EU constitution that requires the euro to be the sole legal tender currency in eurozone countries.” Actually that seems to put a small spanner in the works – is there no limit to the stupidity and lack of foresight of the eurocracy?

What would happen is this. In the (extremely likely) event that the Greeks do not vote on June 17th for parties willing to stick to the country’s agreements with its creditors, the EU (and IMF) would say to Greece that no more euros are to be made available from, say, 1/1/13 (to allow for necessary preparations). Greece nevertheless wants to stay in the euro. The conditions would be these:

All euros in circulation in Greece remain as euros. New bank accounts in drachma are created alongside for those who need them. Euro debts remain euro debts. And the Greek governments euro debts remain payable (it’s too late, unfortunately, for those that have already been forgiven).

Drachma are issued by the Greek central bank, subsequently backed by drachma bonds made available to the domestic market (I say domestic as international lenders are likely to be somewhat sceptical). The drachma floats freely against the euro.

Greece starts paying public sector workers, domestic contractors and state beneficiaries (the unemployed, pensioners etc) in drachma. The private sector has a choice. But companies (say in tourism) with euro debts and euro income would have no need to change their main operating currency. Such Greek exporters are not part of the problem – they can and should remain part of the European single market. It’s the Greek government that is bankrupt. The problem is the Greek public sector, not the private sector.

All Greek shops (and domestic businesses) would be obliged to accept both euro and drachma at an official market rate, say the previous day’s closing mid-market price.

Greece continues to service its international euro debt and recapitalises its banks (in euros, though if drachma are provided, these would have to be immediately converted by the banks). The need for euros for this purpose would be a key factor in determining the value of the drachma and hence public sector wage and other costs. In return (and only if satisfied that the Greek banks are solvent) the ECB would continue to allow Greek banks to borrow from it.

In theory it doesn’t really matter what currency Greece collects taxes in (as they are convertible), but because of time-lags the tax currency should match the currency of the taxable event (i.e. if you’re paid in euro you pay taxes in euro). Note that the drachma is likely to inflate, so the public and companies are likely to want to convert to euro for savings purposes.

Greek import costs are similarly convertible, but since there may be few external holders of drachma, euro would effectively be required. Greece would be forced to balance its trade (and in fact achieve a surplus, given its debts) – and the drachma would fall until it did.

The goals of such a policy are of course to:

Stop the haemorrhaging of deposits from Greek, Spanish and Italian banks. This is taking place because of fear that such deposits will be forcibly converted to a weaker currency, such as the drachma.

Remove the need for further Greek and other bailouts.

Force Greece (and others) to take reponsibility for their own budget and trade deficits.

Allow wages and hence public-spending to adjust in Greece and any other countries that follow the same course.

My flavour of the idea is slightly different from Booth’s in that he doesn’t make such a clear distinction between the public and private sectors of Greece’s economy. What we have in common is the realisation that, as Booth puts it:

“There would be no doubt about the legal status of private debts and credits denominated in euro and little doubt about the legal status of Greek government debt (any doubts would revolve around whether it was denominated in euros or the ‘sovereign currency of the Greek government’ – most likely the former). There would be no capital flight – all euro deposits in Greek banks would remain euro deposits.”

I would say the policy exploits what George Soros terms “reflexivity”. That is, it creates the positive feedback that as soon as it becomes seriously discussed it becomes less worthwhile for Greeks (and Spaniards and Italians) to move their euro bank deposits to Germany, making the policy itself easier to implement.

Note that this desirable reflexivity is in marked contrast to the historically stupid decision to haircut private lenders to Greece, which had the fairly predictable consequence of raising the costs of borrowing by other euro countries perceived by the market to be weak.

I call this the “half-in, half-out” or “Hiho” plan for restoring some kind of normality to the economies of the eurozone’s ailing members and to get the overall European economy moving again. As the ditty goes: “Hiho, hiho, it’s off to work we go!”

Instead I’m going to channel my annoyance at the spoiling of what might have vaguely resembled a sporting event in Barcelona towards the Greeks.

All I want to convey is one simple point, that the Greek people have benefited hugely from the international loans on which they have already partially defaulted and look increasingly like failing to repay in their entirety.

We haven’t invented this thing we call money just for fun. Money allows resources to be allocated. If you borrow it, spend it and fail to repay the loan, you have acquired or consumed resources that could have been used by someone else. Take the Athens metro railway and all the other billions worth of infrastructure to support the 2004 Olympic Games. How was that funded? I’ll hazard a guess. Borrowed money, at least in part. And what will happen to all that capital investment when Greece defaults? It’ll still be there. These assets will remain in existence indefinitely for the benefit of the Greek people. To the extent they haven’t been paid for, they’ve effectively been stolen from the rest of the world.

Some loans may be riskier than others, because that’s how the world is, but, unlike equity investments, loans are designed to be repaid. Financial disruption – on a global scale over the last 5 years – arises when debts are not repaid. So, because of the knock-on effects, Greece’s default is worse than theft! The entire EU has been plunged into recession in large part because of the need for the financial system to prepare for possible Greek default. Instead of using capital to support new lending, banks have been writing down Greek (and other) debt and taking actual losses.

Obviously we’re just reaping what was sown when Greece and other European sovereigns borrowed unsustainably. The question is how to prevent repeats of this cycle of behaviour?

Let’s mull over that question for a minute. What is the popular conception of what’s going on?

I think it was Arthur Smith I heard on the radio yesterday saying the Greeks should be let off their debts because “it’s not the fault” of those protesting. In what sense is that, Arthur? Are you perhaps saying the average Greek took no executive decisions regarding the nation’s finances? Clearly true. But isn’t a large part of the problem that they haven’t paid and continue not to pay their taxes? What do you think is fairer, that every Greek homeowner should pay a special tax (they’re refusing) or that you and I should find the money?

And isn’t a large part of the problem the Greek public-sector? What do you think is fairer, that Greek workers should take whatever pay cuts it takes to balance the books (as has happened elsewhere in Europe, such as in Estonia – now growing again – Latvia and Lithuania) or that you and I should find the money?

Many non-wealthy Greeks must also be culpable of wilfully participating in a cash economy, benefiting from lower prices for services whilst complicit in tax avoidance. What do you think is fairer, that the Greeks start paying taxes commensurate with their public spending like people in most other countries, or that you and I should find the money?

But the really interesting point is that Greece is a democracy. They’ve chosen their own government since the ousting of the colonels in the 1970s. Collectively, then, they’ve repeatedly elected politicians, at least some of which have overspent, undertaxed and cooked the books, or appointed officials to do so on their behalf. Clearly, collectively, the Greeks have benefited from this behaviour. I’m intrigued, Arthur, whether you’re suggesting that, collectively, the Greek people are also not responsible for the situation they find themselves in.

That’s probably enough. After all, Arthur is a national treasure, practically the new Queen Mother, and perhaps a little fragile. Maybe he just didn’t think. Maybe, like the QM, he inhabits a world where decisions are made by waving a magic wand. Maybe, like the QM, he lives in a world where one need take no responsibility for one’s finances.

I also caught a snippet this morning of someone on the Andrew Marr Show invoking the precedent of Argentina. That great and honourable country, that upstanding, exemplary member of the international community most recently defaulted on their debts about a decade ago. And it’s been great for their economy! Who’d have thought it? It’d be great for my personal finances if I went out and bought a house, a car, new furnishings and white goods, new shoes, clothes and so on and then didn’t bother paying for them. I’m sure I’d feel pretty well off for a few years too.

“Yes, the Greeks acted irresponsibly before the economic collapse — the same way my father had acted irresponsibly in his private and professional life. But that is not reason to punish the children, to destroy their future as part of a remedy for a past for which they bear no responsibility.”

What Arianna is saying – for some reason “bleeding heart liberal” is the outmoded phrase that comes to mind – is a little more sophisticated than Arthur Smith’s indignant genialism. We have to draw a line, she says, to protect the innocent. Though, I can’t help pointing out yet again, these “innocent” are nevertheless beneficiaries of the misappropriated funds spent in Greece over the last decade or so. Perhaps they’ll remember that every time they hop on Athens’ shiny new metro trains.

The fear gripping financial markets – and contributing to the unnecessary economic hardship and suffering of innocent little children currently taking place in, say, the UK – is that other countries will follow Arianna’s line of reasoning too. Why shouldn’t Ireland, Spain, Portugal and even Italy say “don’t punish the children”? Having elected profligate, irresponsible governments that have given them what they wanted – low taxes, high spending – why won’t they now elect governments to satisfy their new desire for debt writeoff with some kind of moral justification (right wing nationalist or left wing anti-capitalist – take your pick, or, hey, what the hell, you can even pick both!).

If we want financial stability – quite possibly a good thing, I suggest, in light of the 1930s, just as a for example – then debts have to be repaid. And sovereign debts would be a good start.

So how can the international community protect itself against freeloaders? Against those countries who run up debts, fail to collect enough tax and then, in the words of the song about the girl next door and the bathroom floor, plead “It Wasn’t Me”?

Here’s my suggestion. Many of the countries that default are serial offenders. There’s something deeply ingrained, in their DNA if you like, that leads them to spend too much and collect too little tax. So cut them off from international finance for long enough for them to lose thir habits. This would be simple to implement. The financial services industry is highly regulated (all that effort’s been really effective, hasn’t it?). Regulators in responsible countries (say the UK, the US, the EU apart from Greece) could simply demand that no financial institution or its subsidiaries (maybe even no company) lends at all to a government that has defaulted on sovereign debt over the last 50 years – or maybe even more. Or, crucially, to any institution in that country dependent on its government, such as a bank or a company.

Since holding the currency of the defaulted country would constitute lending, all investment in defaulted countries would have to be funded locally in their own currency. Imports would require foreign currency that would have to be acquired beforehand by local institutions or individuals, i.e. by selling goods and services as exports (or small amounts of currency to tourists and other visitors). No publicly funded export credit guarantees would be available to UK companies, for example. In effect, such countries would be forbidden from running a trade deficit.

Such a measure would do two things. It would financially quarantine serial defaulters for a time longer than short-term market memory currently manages (defaulters tend to return to the international markets within a decade). And it would give non-defaulters pause for thought.

September 17, 2011

You know there’s serious trouble when the Economist runs a two-page editorial, in this case proposing “how to save the euro”.

The Economist agrees with most observers that the problem boils down to how to deal with Greece.

Let’s recap. Greece, a serial defaulter, essentially fiddled the books to understate its debt in order to be admitted to the euro club, hoping for more economic stability. Then the financial crisis came, and, as the saying goes, the tide went out and the Greeks were seen to be wearing no trunks. Not only that, there was an Aegean tsunami on the horizon. Luckily, the Germans had grabbed the deck-chairs so the Greeks aren’t on their own.

What are the Greeks, the Germans and the eurocrats (not to mention the IMF) to do?

What baffles me is the current hysteria from all quarters. Decisive action is not required, as for example, George Osborne insists. The Greek debt is a long-term problem which requires a long-term solution. “Decisive action” implies some kind of quick fix. “Decisive action” is the last thing we need.

In fact, I can see things that can be done to mitigate the situation – economic stimulus measures in the less-indebted eurozone, other European (that includes the UK, Mr Osborne) and other global economies – but I simply can’t see how the central problem could be handled any better than it already is. If that’s not what the markets want to hear then the markets will just have to get over themselves. Some problems just have to be lived with.

Let’s consider the alternatives (I’ve previously written about this on Martin Wolf’s blog at the FT, but I can’t even access that right now, as I terminated my FT subscription in protest at them trying to jack up the price).

1. Greece exits the euro and devalues
This would be catastrophic, at least in the short-term. The Economist discusses the possibility and quotes an estimate that such a step would cost Greece 40-50% of its GDP in the first year (though this seems to assume they leave the EU as well). The trouble is, the “mother of all financial crises” that would result would not be confined to Greece. French and other eurozone banks would take a massive hit, with all kinds of knock-on effects. Even if the initial shock could be contained without seriously recessionary consequences for the remaining eurozone countries, it would simply be a case of “who’s next?” – Ireland, Portugal, Spain, Italy, Belgium, France…

2. Greece devalues within the euro
This is the straw that many are now clinging to, including the Economist, but in fact it’s almost as bad as option 1.

First, there’s the moral argument. Why should the beneficiaries of excessive Greek borrowing be forgiven their debts? Greek taxpayers (or non-payers, by all accounts) would escape paying taxes equivalent to the nation’s long-term spending; all Greeks would have benefited from public services that they haven’t fully paid for; Greek public sector workers would have been paid more than the nation could actually afford – the list is endless. The point is, although different Greek constituencies would no doubt blame each other, the entire nation is complicit, though pre-school children can legitimately claim not to have been in a position to influence matters overmuch.

Second, if Greece is let off a large chunk of its debt, why wouldn’t other countries demand the same? Why should the Portuguese, Spanish, Italians, Irish, French and Belgians suffer tax rises and cuts to their public services if Greek debt is simply written down?

Third, and critically, there’s the problem that a Greek default within the euro doesn’t actually solve the underlying problem. It does something about the debt, but not the deficit. If Greek debt is (say) halved from around 140% of GDP to around 70%, they will still not be credit-worthy, because they’d still be running a deficit. There would still be a need for the IMF, EU and ECB troika to help the Greek government somehow bring revenue and expenditure into line. There’d still be a need for wealthy Greeks to pay more taxes, the Greek public sector to spend less and its economy somehow to grow. In the meantime there’d still be a need for someone to lend euros to Greece.

A Greek default within the euro would simply not have the usual effect of sovereign defaults because it would not be accompanied by devaluation.

In fact, the main effect of Greek default within the euro would be for the Greeks to say “thank you very much”. There’d still be a big hit on eurozone banks (including the Greek ones which would need to be recapitalised from somewhere, and not to mention the ECB), although not the automatic loss from lending to the Greek private sector that would occur in the case of option 1 (when devaluation would make it more difficult, to say the least, for Greek companies to service euro-denominated debt).

Now, it seems to me the troika must recognise this. If I was them I’d demand the budget reforms before allowing any kind of Greek default. In particular, the possibility of Greece having to leave the euro needs to be still on the table. In fact, it wouldn’t surprise me if there hasn’t been a nod and a wink to the off-message officials and politicians (usually German) who regularly float this possibility.

It seems the next payment to Greece is being put off to the last possible moment, even though stumping up is much better for everyone than the alternatives. What puzzles me is that the markets don’t recognise that this brinkmanship is a necessary part of the strategy of forcing Greece to balance its budget in the long-term.

What the Greeks should really be worrying about is the possibility that they haven’t resolved their fiscal problems by the time the rest of the eurozone has recovered (and in particular the banking sector has rebuilt its capital) sufficiently to withstand a Greek default, euro exit and devaluation. Then the eurocrats might just decide to throw them to the wolves.

Still, I wouldn’t rule out a collective loss of nerve and a Greek default within the euro. We’d have to muddle through somehow. If there’s a double-dip, there’s a double-dip – maybe that’s now the least we can expect; if there are further sovereign defaults, the sun will still come up the next morning; if we do end up calling it the Second Great Depression or a Lost Decade, life will still go on. As I said, some problems just have to be lived with.

October 1, 2010

I see John Redwood was up bright and early this morning, blogging away. At 6:34am he posted that:

“…the [cuts] strategy has worked, bringing interest rates on government borrowing down and seeing off a possible Greek or Irish style borrowing crisis.”

Well, maybe. But there’s an alternative explanation which would chill the former Minister’s blue blood. I would have thought traders would pay a lot of attention to the interest rate desired by a central bank able to use QE to drive down yields to whatever level it desires. FT Alphaville suggests that the Fed, at least, might decide to simply target long-term interest rates rather than apply a specific amount of QE. Not a market to short just now, I would have thought. Much safer to bully the Portuguese.

For the record, I can’t help a nasty feeling about all this QE. The danger is letting inflation catch up with us. A bit of inflation right now would be a jolly good way to get rid of all that negative equity. But if inflation expectations sneak up on us the Old Lady would be compelled to sell off her QE bonds at a loss to soak up excess cash. And it would suddenly make new government debt rather expensive.

Um, doesn’t one person’s savings income come from another person’s mortgage interest payment? And won’t house prices fall even further and people become even more alarmed if their monthly mortgage payments rise?

What on Earth does the Member for Wokingham think the economy is? Maybe on Vulcan there are some different principles, but in this part of the Milky Way it’s generally considered that the more money circulates in return for goods and services, the healthier the economy is. Yes, John, money has to circulate. We can’t all stuff our mattresses with it.

Another getting their knickers in a twist over all this is our old friend Martin Wolf over at the FT. If he feels the Coalition’s cuts agenda is dangerous I suggest we listen. And this morning Wolf’s teeth were dripping the blood of the IMF, who (much to the delight of Grant “Anyone for Rugger?” Schapps on Question Time yesterday evening) have dared to endorse the new government’s spending plans.

Personally I think there’s a good chance the whole cuts debate is redundant as – just like in a household – it’s not always that easy to cut back on your spending.

But what really surprised me this week was a rare slip by Wolf. He wrote that:

“The [policy strategy] of slashing the fiscal deficit while the private sector tries to slash its debt suffers from a fallacy of composition: it is impossible for all sectors of the economy [i.e. the public and private sectors] to spend less than income at the same time.”

This is simply incorrect. There is no “fallacy of composition”. The creditors are all private sector, so it is entirely possible for both public and private sector debts to be paid down simultaneously. It’s not the balance between the sectors that matters; it’s what happens within the private sector that’s important. Simply put, to decrease total debt, there needs to be an increase in financial equality (though not necessarily in living standards, since public spending reductions affect the rich financially and the poor non-financially).

Strangely, whilst my first contribution to the debate appeared immediately, my second comment which began by succinctly pointing out Wolf’s error failed to appear on the FT for a couple of days (then appeared twice). I have little tolerance for this sort of thing. It seems to me that the mainstream media who have coopted much of the blogosphere debate have a responsibility to allow debate to actually proceed and make sure their technology works reliably. I was going to have a good whinge. Now I suppose I’ll have to give the FT the benefit of the doubt. Must have been a glitch.

There’s a really big issue here, though.

It’s becoming more and more apparent that the big picture is that inequality is more than just bad for us Spirit(Level)ually – it’s also bad for the economy. Robert Reich has apparently explained this in Aftershock which I was just about to order when I realised I had his Supercapitalism on my shelf. Unread. Not any more though, so I’m off to see who can rush me Aftershock (2-3 weeks say Amazon, tsk).

April 26, 2010

Why do so many travellers, such as those marooned by the Eyjafjallalokull ash cloud, invoke a panic response on finding they can’t leave a foreign land? I remember that when I was on a memorable trip to Albania in, if I recollect correctly, 1996, our group was playing leapfrog, as it were, with another minibus full of tourists, along a road to the coast. When we stopped – often – for a passenger to relieve the symptoms of one or other of the local stomach-bugs, the other bus passed us, only for us to see them stopped by the roadside a few minutes later. Eventually we pulled up beside them to chat. It turned out that Albania’s borders were shut, in the hope of trapping whoever had blown up the Tirana police-chief. The other group were cutting their trip short. So illogical. We simply carried on with our holiday. [I drafted this a few days ago, but, since then, I’ve heard, Radio 4’s Today programme is discussing the psychology – and even genetics – of the have-to-get-home phenomenon, right now!].

It beats me why so many people spent thousands of euros hiring cars to drive across Europe. Surely staying until the ash alert blew over would have been both cheaper and less stressful.

“Huybers and Langmuir spliced two databases of volcanic eruptions worldwide over the last 40,000 years.

Eruption levels stayed low until around 12,000 years ago, then suddenly they suddenly shot up. The melting ice released so much pressure that the newly liberated volcanoes erupted at up to six times their normal rate, the researchers estimated.

The inferno lasted for 5,000 years and could have pumped enough CO2 into the atmosphere to raise concentrations between 40 and 50 parts per million, the researchers estimate. Changes in ocean chemistry probably released the rest.”

I love the eruption levels “suddenly” shooting up “suddenly”!

Now, a couple of kilometres of ice over a volcano is one thing. It’s reasonable to suppose that would prevent the pressure in a magma chamber that would otherwise have caused an eruption from doing so.

But melting a kilometre or so of ice takes quite some time. And besides, since the last ice age, there aren’t so many ice-sheets left. Worst case, in a few centuries, perhaps, we could feel the effects of some pent-up volcanic activity.

In the meantime, the worst that could happen is that some eruptions are brought forward by a few years.

The hype around the volcano scare exploits our innate difficulty in conceiving long periods of time. It also resonates with research a while back which noted more eruptions at certain times of year. The suggestion was that particular weather conditions – changes in pressure – around volcanoes, could set them off.

This triggering is an entirely different kettle of fish.

Volcanoes and the weather or short-term climate change

Consider a simple model of volcanic eruptions as the sudden release of something we might call “pressure” that builds up over time. Let’s suppose that the main cause of the build-up of “pressure” is geological. Let’s also assume that the weather can cause seasonal variations in pressure. In this model, eruptions will occur when the total pressure crosses some threshold, as in the following diagram:

Because I’m lazy, and Powerpoint is a step back from pen and paper (and reverting to that and scanning is a hassle right now), I’ve shown the total pressure (dotted line) as the sum of the geological pressure and seasonal variations for the first eruption only, but hopefully you get the idea.

It’s not very usual for volcanoes to erupt every 3-5 years, of course – 50 years or so might be more usual – and in real life every eruption is different.

Hopefully, though, it’s fairly easy to see that eruptions are much more likely in this system during the period when the seasonal effect tends to increase pressure. Over this period the total pressure (dotted line) increases much faster than when the seasonal effect is to decrease pressure.

In fact – and hold this thought – if the rate of increase in pressure due to short-term variability is faster than the long slow build-up of pressure, then eruptions, according to this simple model, will always occur during the short-term upswing in pressure.

My proposition is that it is very easy to exaggerate the effect of the seasonal cycle as a “cause” of eruptions. It is merely a trigger.

You can also see that, if, say, the seasonal pressure changes – a gradual trend on top of the annual fluctuations, perhaps, or an increase in amplitude of the cycle – it will not have a large effect on the frequency of eruptions over a long period. The periodicity of the system will still be driven by geological processes. The weather is a secondary driver in this system.

Now, if you didn’t know that volcanic eruptions are caused by a build-up of “pressure” underground, you might hypothesise that they’re caused by weather conditions. You might collect a lot of data and calculate correlation coefficients to “prove” your theory. You might even argue convincingly that, because we know what causes the weather, the weather must cause volcanic eruptions rather than vice versa and furthermore, it is not the case that both the weather and volcanic eruptions are caused by a third factor.

But anyone who’s stayed awake this far will realise that it’s not enough to determine a correlation between solar cycles and weather patterns. Maybe the solar cycle does trigger a change from one state of the AMO (Atlantic Multidecadal Oscillation) to another. But that doesn’t make it the sole or even the main cause of the variability.

To recap, I first explored the idea of the AMO when I became concerned that the emphasis being put on shrinking Arctic ice as an indicator of global warming (GW) could backfire if the shrinkage reverses. My first post on the topic was therefore titled: Spin Snow, Not Sea Ice, the AMO Is Real!. Back then, I noted that the AMO cycle – likely to be variable in length, especially now we have the extra GW complication – tends to be of the order of 60 years or so, with the previous cooling phase lasting from the 1940s to the 1970s. Maybe we’re entering another one.

That first post suggested a mechanism for the AMO, which I discussed a little more in my second post on the topic, Why the AMO Overshoots. So I won’t repeat myself today.

The basic argument in all these posts is that the natural cycle – the AMO – is characterised by a set of feedbacks. Positive feedbacks – perhaps including the effect of lying snow, as considered in That Snow Calculation – produce distinct warming (Arctic ice melt) and cooling (Arctic ice recovery) phases. Negative feedbacks cause one phase to flip to the other. But the exact timing of the tipping-point may be caused by external triggers.

My proposition is that by the end of warming phase of the AMO, the seas (especially the Arctic and the North Atlantic) are relatively warm compared to the land. Any sudden cooling event could trigger a flip to the cooling phase, because the land cools quicker than the ocean, so would become relatively even colder.

The sunspot cycle indicates the total irradiance from the sun, and the rate of variation is comparable to that of other causes such as GW:

IPCC Fig 2.16 recent changes in solar irradiance

Further Implications

Not too many scientists claim volcanic eruptions are “caused”, as opposed to triggered, by variation in the weather or by climate change. Most understand that only over the sort of long timescale that is needed to melt an ice-sheet would the frequency of eruptions change.

But far more common is the explanation of apparent climate cycles – such as the AMO – by variations in solar output. In cases such as this, it is necessary to do more than just prove a correlation. The causal mechanism needs to be clear and must be shown to be quantitatively sufficient to explain the observed phenomena.

Considerable care is required whenever attempting to explain the “causes” of complex system behaviour.

The need to distinguish between triggers and underlying causes of cyclic behaviour also applies elsewhere in the climate system. Furthermore, the distinction between triggers and underlying causes may become blurred – both may be of similar magnitude, creating a resonant system. In particular, over longer timescales than so far discussed, the Milankovitch cycles are not enough alone to explain the ice age cycle. Perhaps they resonate with another cycle internal to the climate system.

In other domains too, it is not possible to assume that the “cause” in a complex system is just that which is evident on the surface. The lax lending practices and cheap money that are held to have caused the credit crisis may just be one part of a deeper, more complex cycle of optimism, deregulation, increased trade and globalisation on one hand and retrenchment and nationalism on the other.

November 3, 2009

The upcoming Lloyds rights issue is in fact quite simple. They are giving shareholders the right to buy ~50p worth of new shares for each of the currently existing shares they hold. The new shares will be offered at a discount, but their price has not yet been set, so, obviously, you cannot yet determine how many new shares you can buy. But you’ve been told, albeit somewhat cryptically, what you need to know right now: if you want to take up your rights, you’re going to need to find 50p for each share you own when the rights issue process starts on 20th November. [Summary paragraph added 8:45am 4/11/09].

But is it just me or is the organisation and presentation of this rights issue more complicated than it needs to be? [Reworded 8:45am 4/11/09].

I quote in full section 10 of Lloyds’ announcement of its rights issue:

“10 Share Subdivision

Under the Companies Act, it is not permissible for a company to issue shares at a discount to their nominal value, which, in respect of the Existing Ordinary Shares is currently 25 pence per share. It is proposed that the Company carries out the Share Subdivision which will reduce the nominal value to 10 pence per share. This provides the Company and the Joint Bookrunners with greater certainty that the Issue Price will be able to be set at a 38 per cent. to 42 per cent. discount to TERP [the Theoretical Ex-rights Price, which itself depends on the number of new shares being issued, so a bit of algebra is needed to determine the issue price for 38-40% discount based on the current trading price of the existing shares] irrespective of market conditions. The Board believes that the Share Subdivision also provides the Company access to the best available underwriting structure and terms. Although no decision has currently been made as to the Issue Price, in no circumstances will the Issue Price be below 15 pence. As noted in paragraph 8 of this letter, the Issue Price is expected to be announced on 24 November 2009, two days before the General Meeting. The Proposals are conditional on, amongst other things, the completion of the Share Subdivision.

It is proposed that, pursuant to the Share Subdivision, each existing Ordinary Share of 25 pence in issue at the close of business on the date of the General Meeting will be subdivided into one ordinary share of 10 pence in the capital of the Company (a “10p Ordinary Share”) and one deferred share of 15 pence in the capital of the company (a “Deferred Share”). The purpose of the issue of Deferred Shares is to ensure that the reduction in the nominal value of the Ordinary Shares does not result in a reduction in the capital of the Company.

Each Ordinary Shareholder’s proportionate interest in the Company’s issued ordinary share capital will remain unchanged as a result of the Share Subdivision. Aside from the change in nominal value, the rights attaching to 10p Ordinary Shares (including voting and dividend rights and rights on a return of capital) will be identical in all respects to those of existing Ordinary Shares. No new share certificates will be issued in respect of the 10p Ordinary Shares as existing share certificates for existing Ordinary Shares will remain valid in respect of the same number of 10p Ordinary Shares arising from the Share Subdivision. The number of Ordinary Shares of the Company listed on the Official List and admitted to trading on the London Stock Exchange’s main market for listed securities shall not change as a result of the Share Subdivision. The Share Subdivision will not affect the Group’s or the Company’s net assets. Consequently, the market price of a 10p Ordinary Share immediately after completion of the Share Subdivision should, theoretically, be the same as the market price of an Ordinary Share immediately prior to the Share Subdivision.

In addition, it is proposed that, pursuant to the Share Subdivision and as required by Article 3.1.4(i) of the Articles of Association, each existing Limited Voting Share of 25 pence in issue at the close of business on the date of the General Meeting will be subdivided into one limited voting share of 10 pence (a “10p Limited Voting Share”) and one Deferred Share. Aside from the change in nominal value, the rights attaching to 10p Limited Voting Shares will be identical in all respects to those of existing Limited Voting Shares. No new share certificates will be issued in respect of the 10p Limited Voting Shares as existing share certificates for existing Limited Voting Shares will remain valid in respect of the same number of 10p Limited Voting Shares arising from the Share Subdivision.

The Deferred Shares created on the Share Subdivision becoming effective will have no voting or dividend rights and, on a return of capital on a winding up of the Company, will have the right to receive the amount paid up thereon only after Ordinary Shareholders have received, in aggregate, any amounts paid up thereon plus £10 million per Ordinary Share.

No share certificates will be issued in respect of the Deferred Shares, nor will CREST accounts of shareholders be credited in respect of any entitlement to Deferred Shares, nor will they be admitted to the Official List or to trading on the London Stock Exchange or any other investment exchange. The Deferred Shares shall not be transferable at any time, other than with the prior written consent of the Directors. The rights attaching to, and restrictions upon, the Deferred Shares are set out in Resolution 6.

At the appropriate time, the Company may repurchase the Deferred Shares, make an application to the High Court for the Deferred Shares to be cancelled, or cancel, or seek the surrender of the Deferred Shares using such other lawful means as the Directors may determine.”

Got that? You’ll be tested on it later!

In fact, all section 10 says is that to get round some stupid rule, and in case Lloyds shares fall before the rights issue completes, we’re all going to be issued with “deferred shares”. These are totally worthless. I just hope they don’t actually show on my trading account, cluttering up the screen and statements.

Frankly, who cares about the nominal value of shares? And, if the rule that companies can’t issue new shares at below the nominal value of existing shares is so easily circumvented, does it really have any point? Maybe the law could simply be changed to add “unless approved at an AGM”.

I’d rather the army of accountants and company lawyers running large companies were employed making sure the business doesn’t screw up, not worrying about worthless deferred shares. Someone was obviously paid to write the paragraph that ensures the deferred shares are worthless. On the other hand, maybe it was worth it for the amusement value. I like it so much I’ll quote it again, this time with a bit of emphasis:

“The Deferred Shares created on the Share Subdivision becoming effective will have no voting or dividend rights and, on a return of capital on a winding up of the Company, will have the right to receive the amount paid up thereon only after Ordinary Shareholders have received, in aggregate, any amounts paid up thereon plus £10 million per Ordinary Share.”

Perhaps they should index that £10 million to RPI. We might experience hyperinflation.

Lloyds is also waiting till the last minute before telling us what the issue price of the new shares will be, in case the short-sellers get their teeth into the situation. Actually I don’t care very much. What I want to know is how much I’m going to have to put in for each share I own. Then I can calculate the total amount I need to find. Shareholders are being asked for about 50p per share they own at the record date for the issue (20th November), calculated by dividing the amount to be raised (£13.5bn) by the number of shares in circulation at the moment (just over 27bn, a number which won’t change materially over the next couple of weeks). Lloyds’ announcement could easily have included the exact amount as a headline (I haven’t read all 200,000 pages of the documents they’ve issued today).

Rights issues remain dysfunctional as I explored here, here and here around 18 months ago (when HBoS was passing a hat around, ironically enough). All that’s been done is to try to speed the rights issue process up, which introduces new problems: the regulators haven’t speeded up the process of moving money about, and the post, for obvious reasons, is even less reliable right now (let’s hope we can all exercise our rights online or by telephone, eh?). As I said in my previous posts on this topic, it must be possible to devise a way of raising funds from shareholders that isn’t vulnerable to attack by short-sellers. Such a scheme would surely save on underwriting fees, for starters. Lloyds will only raise £13bn net from its £13.5bn rights issue. I can live with putting money into basically sound companies that need it, but it sticks in the craw that so much disappears in transaction costs (and in this case, a windfall tax in all but name). Especially when I’m not going to get any dividends for another 2 years!